21 May 2025
Hindsight or foresight: The psychological trap costing businesses
Aaron Jones explains how predicting the FX market is virtually impossible and a better strategy for businesses is to anticipate and ensure they’re prepared for various scenarios.
Exchange rates are influenced by a complex web of factors: interest rates, inflation, trade balances, government debt, economic outlooks, political stability, and market sentiment. With so many moving parts, consistently timing the foreign exchange (FX) market is near impossible.
In a recent survey of our FX clients*, 65% of respondents said they hedged to manage currency exposure. Yet, over half (51%) of respondents acknowledged that they “timed the market incorrectly”. Is this a sign that they could have done better? Or simply proof that hindsight is always clearer than foresight?
It’s tempting to think that looking back at past currency moves will accurately predict the future. Karl Pearson’s Random Walk theory suggests otherwise – past steps offer little guidance for future ones, especially in financial markets.
Whilst hindsight can help inform potential future outcomes – such as knowing that a currency often weakens when interest rate cuts are expected – even experts can be caught off guard by market shocks. For example, the sudden impact of Trump’s ‘Liberation Day’ tariffs. While tariffs were anticipated, the scale surprised the markets and triggered sharp corrections across asset classes including equities, bonds and currencies.
Rather than relying on prediction, a more robust approach is to consider a range of possible market outcomes, assess their potential impact on a business and plan accordingly.
Only 21% of respondents to our survey said their 2024 FX strategy fully achieved their objectives and 61% would have changed some aspect of their FX strategy. This reinforces the thesis that prediction is not a reliable foundation for decision making. A more effective strategy is to understand how different scenarios in foreign exchange markets could affect a business and ensure preparedness for each of them.
Understanding your outcomes
The cornerstone of an effective FX strategy is deliberate planning. Even if a decision is taken not to hedge, it should be a conscious decision, not one made by default. It is important to align any approach to currency exposure with the specific needs of a business including cashflow, profitability and risk tolerance.
Hedging can provide business certainty and peace of mind. It will not deliver the best possible financial outcome in every scenario, but it will assist in avoiding nasty surprises and ensure a range of outcomes can be tolerated.
The insurance market offers an easy parallel. Consider house insurance:
- The premium is £500.
- If you don’t insure, you save the premium if nothing happens, but risk losing everything if disaster strikes.
- If you insure, your downside is capped at £500, whatever happens. If there’s no disaster, some might consider the premium wasted, but you’ve paid for peace of mind and protection from significantly larger loss.
It’s not a binary decision
Hedging doesn’t have to be all or nothing, nor does it require a single product approach. You can hedge part of your exposure, leaving the rest to be managed at prevailing market rates. Or add additional hedges if market conditions become favourable.
Equally, a mix of products, including spot, forwards, vanilla options, or more structured trades, can create a portfolio approach. This allows risk management while retaining flexibility and capturing a broader range of potential outcomes than simply fixing a rate forward.
Where corporates are using a portfolio approach, it’s useful to develop an FX roadmap that models potential market moves, and the resultant exposure coverage and effective FX rate across those scenarios, ensuring an appropriate plan, for all scenarios is devised.
The importance of counterparty risk
When implementing hedging strategies, businesses must also consider counterparty risk – the possibility that the institution providing any hedging product could default on its obligations. This risk is often overlooked, particularly by businesses without dedicated treasury teams.
To mitigate this, it is important to prioritise working with financially robust, regulated institutions. Hedging strategies should prioritise counterparty certainty as well as cost and flexibility.
Regular reviews
Once a strategy is in place, it is important to regularly review it. Considerations should include whether it is still working as intended, if business operations have changed, and whether any new scenarios have emerged that should be considered.
The goal is to be proactive and objective, adjusting strategies to improve resilience across a range of market outcomes. Hedging is about understanding risks and making suitable decisions. Future success should never be left to chance.
* Survey of corporate FX clients, counting 151 respondents in the UK and 53 in Europe conducted by Investec in February 2025.
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Meet our expert
Aaron Jones
Head of Treasury and Risk Management
My focus is on developing new solutions for our corporate clients’ risk management, including mitigating rate and inflationary risk. Going beyond the expectations of our clients is something I really enjoy. After graduating from University College London with a degree in Mathematics with Economics, I spent much of the previous decade earning my stripes at RBS.
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